Legendary fund manager Li Lu (whom Charlie Munger supported) once said, “The biggest risk in investing is not price volatility, but the possibility that you will suffer a permanent loss of capital.” So it seems like smart money knows that debt – which is usually involved in bankruptcies – is a very important factor, when you assess the level of risk of a business. Like many other companies Columbus Energy SA (WSE: CLC) uses debt. But the real question is whether this debt makes the business risky.
What risk does debt entail?
Generally speaking, debt only becomes a real problem when a company cannot repay it easily, either by raising capital or with its own cash flow. In the worst case scenario, a business can go bankrupt if it cannot pay its creditors. While it’s not too common, we often see indebted companies continually diluting their shareholders because lenders are forcing them to raise capital at a ridiculous price. That said, the most common situation is where a business manages its debt reasonably well – and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash flow and debt together.
Check out our latest analysis for Columbus Energy
What is the debt of Columbus Energy?
You can click on the graph below for historical figures, but it shows that in September 2021 Columbus Energy had a debt of Z391.7million, an increase from Z104.8million, on a year. On the other hand, it has Z70.8million in cash, resulting in net debt of around Z320.9million.
How strong is Columbus Energy’s balance sheet?
We can see from the most recent balance sheet that Columbus Energy had a liability of Z263.1million due within one year and Z294.5million liability beyond that. On the other hand, he had cash of Z70.8million and Z85.5million in receivables due within one year. Thus, its liabilities exceed the sum of its cash and (short-term) receivables by Z 401.4 million.
While that might sound like a lot, it’s not that big of a deal since Columbus Energy has a market cap of z 1.65 billion, and could therefore likely strengthen its balance sheet by raising capital if needed. But we absolutely want to keep our eyes open for indications that its debt is too risky.
We measure a company’s indebtedness relative to its earning power by looking at its net debt divided by its earnings before interest, taxes, depreciation, and amortization (EBITDA) and calculating the ease with which its earnings before interest and taxes (EBIT ) covers its interests. costs (interest coverage). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.
While Columbus Energy’s debt-to-EBITDA ratio of 5.7 suggests heavy leverage, its interest coverage of 7.9 implies that it is servicing that debt with ease. Overall, we would say it seems likely the company is carrying some pretty heavy debt. It is important to note that Columbus Energy’s EBIT has fallen 24% over the past twelve months. If this decline continues, it will be more difficult to pay off the debt than to sell foie gras at a vegan convention. When analyzing debt levels, the balance sheet is the obvious place to start. But it is the earnings of Columbus Energy that will influence the performance of the balance sheet in the future. So if you want to know more about its profits, it may be worth checking out this long term profit trend chart.
Finally, a business needs free cash flow to pay off debts; accounting profits are not enough. The logical step is therefore to examine the proportion of this EBIT that corresponds to the actual free cash flow. Over the past three years, Columbus Energy has spent a lot of money. While investors no doubt expect this situation to reverse in due course, this clearly means its use of debt is riskier.
Our point of view
To be frank, Columbus Energy’s conversion of EBIT to free cash flow and its history of (not) growing its EBIT makes us rather uncomfortable with its debt levels. But at least it’s decent enough to cover its interest costs with its EBIT; it’s encouraging. Overall, it seems to us that Columbus Energy’s balance sheet is really very risky for the company. We are therefore almost as wary of this stock as a hungry kitten falls into its owner’s fish pond: once bitten, twice shy, as they say. The balance sheet is clearly the area to focus on when analyzing debt. However, not all investment risks lie on the balance sheet – far from it. To this end, you should inquire about the 5 warning signs we spotted with Columbus Energy (including 3 which are a bit unpleasant).
Of course, if you are the type of investor who prefers to buy stocks without going into debt, feel free to check out our exclusive list of cash net growth stocks today.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents. Simply Wall St has no position in any of the stocks mentioned.